Banks use sign language to show their interest

In the slow-motion crisis that is the European sovereign debt debacle we’ve reached the stage where the major Australian banks are issuing dire warnings about their cost of funds. But in this rerun of the global financial crisis one element is missing – bank chiefs talking about where they will move their interest rates.

The federal government’s ban on bank price signalling has not yet been signed into law but it is already affecting how banks speak about their business. The laws will attract penalties of up to $10 million if a bank publicly discloses information designed to substantially lessen competition, and banks are already running themselves as if they are in place.

Advocates insist the laws are needed so banks don’t co-ordinate their out-of-cycle rate moves. Critics warn it will chill the spread of information to the detriment of customers, who need to know where rates are likely to head. The last few weeks show that life is continuing very much as always.

Bank chiefs have been making plenty of comments that give a pretty good idea that pocketing part of the expected rate cuts may be on the cards – signalling without an explicit signal.

Commonwealth Bank of Australia
chief
Ralph Norris
said after presiding over his final annual general meeting in Brisbane last month that, “over the next two, three, four years, the cost of money is going to get much more expensive and I don’t see any other choice than financial institutions internationally will pass on the additional costs".

ANZ Banking Group
chief
Mike Smith
has been typically bearish. “This is fundamentally a European problem and the issue is there is a contagion," he said in the past week. “There is a credit crunch in Europe now, it is spreading to Asia and it will spread here too."

Markets expect the Reserve Bank of Australia to cut interest rates on Tuesday, and another four cuts are expected in 2012. That gives banks plenty of room to hold back part of the cuts and widen their margins. Provided they can deal with the reputational fallout, something that is much easier to do when they move in a pack, there is a lot of money to be made. Are banks simply telling it like it is, or are they attempting to signal?

The federal government seems in little doubt. In the past week federal Treasurer
Wayne Swan
warned he had told each bank that given their margins were at pre-crisis levels, they had “absolutely no excuse" not to pass on any rate cut in full.

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Banks are within their rights to talk about funding pressures, and in many ways the price signalling bill is a bad law: markets only work freely when there is a free exchange of information. That said, there is something curious about the timing of the depressive state of mind that has hit our bank chiefs.

Only weeks ago they were upbeat about their ability to avoid being affected by Europe. Typical was chief executive
Gail Kelly
at
Westpac
’s full-year results on November 2 when she pointed out that strong deposit growth had enabled Westpac to sit out the market volatility since August.

“If we needed to, we could actually not do any term funding at all over the whole course of next year," she said.

Bank CEOs now talk of another financial crisis. The European situation has indeed worsened, although it has been getting steadily worse for two years. Their credit ratings have been lowered a notch, but as CBA said on Friday, this would not have a material impact on their cost of funds.

The shift in temperament pivots around one event that lies close to home. When the cash rate was cut by 0.25 of a percentage point in November
National Australia Bank
kept 0.05 of that for itself – which added about $50 million in profit to its bottom line.

Swan pulled out his lettuce leaf and gave NAB a slap for being “greedy" but shadow treasurer
Joe Hockey
didn’t make a fuss. If the RBA cuts rates on Tuesday, the banks can take heart that the environment seems more forgiving than the public outcry when CBA pushed up rates last November.

So are costs of funds rising? Citi analysts say only 15 per cent of bank funds originate overseas, compared with 20 per cent at the start of the GFC. A flight to less risky havens is causing US money market funds to move their cash – some $US1 trillion ($990 billion) worth – out of Europe and into Australia.

The spread between the Australian dollar LIBOR rate and the overnight cash rate – a gauge of short-term borrowing costs – has widened to about 0.2 of a percentage point but remains well below 2008, when it regularly spiked by three times this amount. Deposit growth is strongly outstripping loan growth, so banks can fund new loans from deposits.

In fact, it is the cost of deposits that will have the biggest impact on funding costs – something very much in their own control. At worst, bank margins may be affected by 0.04 of a percentage point during 2012, Citi says.

“Regardless of fears over global market turmoil, the large majority of Aussie bank funding is sourced domestically, where retail funding costs relative to cash rates have remained stable over the last year," it says. “With three bank CEOs warning in the last week of a possible return to the credit crunch conditions of late 2008 and 2009, banks would appear to be positioning themselves to hold back some part of the next cut in overnight cash rates." The message got through in the end.